That sure looks like a disincentive to me.

May 25th, 2012 by Joe Kristan

Linda Bealeresponds to the piece I linked to yesterday about the disincentives to increased income created by the earned income tax credit phaseout. She cites a study that doesn’t really address the question and then says “look, a squirrel” that the real problem is gender bias.

A single parent in Connecticut with two young children could have received over $18,000 in transfer benefits if she had no earnings and no income, assuming her pre-subsidy rent was $600 per month. But suppose her earnings increased to $17,000 (poverty level) – spread evenly throughout the year – increases in childcare costs (assumed to be $250 per month before subsidies) and payroll taxes would have reduced her earnings by almost $2,000. Income tax credits and transfer benefits would have then added $16,500 – for a total net income of almost $33,000. If her income increased to twice poverty, she’d have to pay almost $5,600 in subsidized child care costs, state income taxes and payroll taxes. She’d receive about $6,400 in tax and transfer benefits – for a net income of $35,000. Thus, doubling her wages from $17,000 to $34,000 resulted in a net change in income of only about $2,000.

To say that result doesn’t discourage work is to say that the poor are bad at math. No, not all of the lost benefits are from the earned income credit phaseout, but that’s an important part of the picture. The phase out of welfare benefits, including earned income credits, can cause marginal rates at some levels to exceed 100%. That problem doesn’t go away no matter how much Linda Beale frets over gender bias. Arnold Kling has made more constructive suggestions:

There are two potential solutions. One solution is to base eligibility for means-tested benefits on total income, including other government benefits programs. Another approach would be to abolish a lot of specific programs and replace them with generic cash assistance.

Simply jacking up the benefit levels of existing programs only makes the disincentive problem worse.